Recession A Case On Government Policies

Question: Discuss how the Government can use various policy tools to either avoid or limit the negative effect of a recession. Answer: Introduction: In macro economics, recession alludes to a contraction in trade or business cycle. More precisely, it is a slowdown of economic activities and downturn in any concerned economy. A significant fall in spending gives rise to recession (The Economic Times, 2015). Example although being the third largest economy, Japans economy contracted to 1.9% annually in July to September, 2014. Recession in an economy is allied with: Inflation which is high. Unemployment which is high. Slowing GDP (Gross domestic product). Falling income. Falling prices. Falling interest. In a market sector or market economy, the national government and other monetary authorities implement policies to avoid recession depending upon the causes of recession. Aggregate demand (like invest, exports, consumer spending) needs to be increased (Viard, 2009). The govt. has 2 types of economic policies in order to control aggregate demand, viz. fiscal policy and monetary policy. When economy is stimulated with these policies, the govt. is adopting expansionary fiscal policy. When the economy is contracted, the govt. adopts contractionary fiscal policy. Normal Fiscal policy indicates: Lowering taxes Increasing spending of govt. and or Increases in transfer payments (Well, 2015). Corollary: But an overheated expansion, contractionary policy is desirable and it means: High taxation. Lowered spending. Thus, Lord Keynes opined, recession needed deficit spending and overheated expansion need a budget surplus. Considerations needs o be taken by govt.: The govt. can imply stimulus that are short termed and structural changes that are long termed. Spending is required to be boosted by the government. Low bond yield as an advantage should be taken (Well, 2015). The increase in fiscal stimulus (discretionary) shall: Create new jobs. Boost the AD (aggregate demand). Improve the confidence of consumer and businesses. Simultaneously, govt. requires setting out material plans in dealing with long term spending commitment. Decisions should be made by the govt. which reduces long termed entitlement spending, viz. Rising the retirement age. Put caps on costs of health care (Well, 2015). Increases the taxes (delay till after the recession). Recession avoidance by policies (fiscal and monetary stimulus): Govt. Fiscal policy (expansionary) works in two ways, viz. taxes and spending. But for our usefulness, it is better to segregate in three tools viz, taxes, transfer payments and govt. purchases. By cutting rate of interest: Aggregate demand is boosted by cutting rate of interests. If interest rates are lower, it reduces the interest payments of mortgage. This gives more disposable income (DI) to consumers. This lower interest rate induces consumers and firm to spend more rather than saving (Pettinger, 2008). If higher interest rates are the cause of recession, then by cutting rate of interest can help in avoiding recession. It may be however noted that if there is a huge drop in assets prices, the banks loose. This is because even if interest rates are shelved, bank may not lend. But in the year 2008 to 2009, in UK interest rates were lowered by 0.5% but UK could not avoid recession. The central bank will lower interest rates and increases the supply of money in the economy. Preventing house re-possessions: The govt. can try freezing mortgage rates in preventing home re-possessions. House re-possessions cause banks to loose and also a decrease in consumer spending. Fiscal policy (expansionary): Fiscal policy (expansionary) works two folds on part governments fiscal budget, viz. taxes and spending. But t is useful if we separate these 2 sides into 3 specific tools, viz. taxes, govt. purchases transfer payments. Consumers DI increases when there is a cut in taxes. But it induces higher borrowing by govt. We can cite the example of Japan and Abenomics. Japan has a public debt of 240%. But Greece, Italy and Ireland will not benefit from this fiscal policy as they have seen rise in govt. bond yield (Pettinger, 2008). Again, it is not guaranteed that spending shall be boosted by lowering taxes if the confidence is less. The govt. can subject to higher spending as regards to capital investments project. Money will be thus injected in the economy directly. This shall prove more effective than cutting taxes if cut in taxes are saved just. Closing recessionary gap, decreasing the rate of unemployment and stimulating the economy is the primary goal of fiscal policy. It can lead to larger budget deficit by govt. or a lesser budget surplus. Transfer payments: These payments are made by govt. to households in expectation of no productive activities in return (Economics.fundamentalfinance.com, 2015). These are welfare to the people who are poor, unemployment compensation for the unemployed people, security benefits to disabled elderly people. Devaluation: There can be a boost in AD if there is devaluation in exchange a rate. Example, a drop in the value of pound makes imports dearer and exports cheaper, increasing the domestic demand. But if we take into consideration the in global recession, exports demand shall be inelastic (quite). Also countries may start competitive devaluation in global recession. This happens when various countries tries to attain competitive advantage by devaluating their home currency against other foreign currency. But it may prove self defeating (Pettinger, 2008). Quantitative easing: Unusual monetary policies shall be adopted by central bank if the interest rate is already 0 (zero). Thus, the central bank would involve in creating money electronically. This money shall be used in buying securities that are long dated. This will increase banks reserves. This in turn will encourage banks to lend. Also, it will reduce rate of interest on bonds. This will in turn help in encouraging investments and spending. To buy long term securities can play an important role to increases supply of money in the economy (Amosweb.com, 2015). Conclusion: Govt. can avoid recession by fiscal and monetary measures. But implying these stimuli depends upon the nature of the recession. It may work in a particular nations recession. But for global recession some added means are required. Example lowering rates did not work for UK. References: Amosweb.com, (2015). AmosWEB is Economics: Encyclonomic WEB*pedia. [online] Available at: https://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpdc=dspk=expansionary+fiscal+polic [Accessed 20 Jul. 2015]. Economics.fundamentalfinance.com, (2015). Fiscal Policy - Macroeconomics. [online] Available at: https://economics.fundamentalfinance.com/fiscal-policy.php [Accessed 20 Jul. 2015]. Economics.fundamentalfinance.com, (2015). Fiscal Policy - Macroeconomics. [online] Available at: https://economics.fundamentalfinance.com/fiscal-policy.php [Accessed 20 Jul. 2015]. Pettinger, T. (2008). Economics Essays: Can Recessions be Avoided?. [online] Econ.economicshelp.org. Available at: https://econ.economicshelp.org/2008/07/can-recessions-be-avoided.html [Accessed 20 Jul. 2015]. Pettinger, T. (2011). Economics Essays: Policies to Avoid Recession. [online] Econ.economicshelp.org. Available at: https://econ.economicshelp.org/2011/09/policies-to-avoid-recession.html [Accessed 20 Jul. 2015]. The Economic Times, (2015). Recession Definition | Recession Meaning - The Economic Times. [online] Available at: https://economictimes.indiatimes.com/definition/Recession [Accessed 20 Jul. 2015]. Viard, A. (2009). Tax Policy during the Recession: The Role of Fiscal Stimulus. [online] AEI. Available at: https://www.aei.org/publication/tax-policy-during-the-recession-the-role-of-fiscal-stimulus/ [Accessed 20 Jul. 2015]. Well, D. (2015). Fiscal Policy: The Concise Encyclopedia of Economics | Library of Economics and Liberty. [online] Econlib.org. Available at: https://www.econlib.org/library/Enc/FiscalPolicy.html [Accessed 20 Jul. 2015].